How Should Crypto Lending Be Regulated Under EU Law?

Abstract

The collapse of Genesis is the latest in a cascade of failures of crypto lenders. The last year has seen numerous major crypto lenders, such as Celsius, Voyager and BlockFi, going out of business in domino-like fashion. The failures have revealed the vulnerabilities of crypto-market lenders’ business model, most notably the liquidity and maturity mismatches in their loan portfolios, and their markedly weak corporate governance. The present article explores avenues to regulate crypto lending within the framework of EU financial services regulation. It argues that crypto lenders should be taken as falling within the definition of credit institutions under EU law, and thus, as a result, should be subject to the stringent licensing and prudential requirements introduced by the Capital Requirements Directive and Regulation. Prudential regulation is one of the ways that have been suggested for the regulation of crypto-market operators, alongside the investor protection framework. Taking into account that crypto lenders easily operate on a cross-border basis and that prudential regulation is fully harmonized in the EU, we take an EU-wide perspective and focus our analysis on EU law, rather than member state laws. In addition, prudential regulation can deal with any systemic risk issues with which investor protection regulation cannot deal. However, in order to avoid moral hazard and not give investors the false impression that crypto lenders are safe too-big-to fail institutions, we suggest that crypto lenders should not enjoy the full protection of prudential regulations. In particular, they should not be offered lender of last resort support and they should not be allowed to subscribe into a deposit insurance scheme. Even though it is often said that crypto markets pose no risk to the regulated sector due to limited interconnectedness, it should be noted that due to the high leverage of crypto investors, the real risk to the regulated sector comes from the possibility of crypto investors massively liquidating their positions in other asset markets.